What are the options when looking to raise debt finance?

18 December 2018

Background to the debt finance market

Over the past decade the UK and global economy has been through a protracted period of change and uncertainty, with governments being forced to take action to bolster their domestic economies and stimulate growth through both fiscal and monetary policy. The collapse of Lehman Brothers was, in many people’s view, the start of a radical shift in the banking sector with banks under a huge amount of pressure, both in terms of performance and regulation.

With the UK government providing bail outs to a number of financial institutions at this time, it was evident that something needed to be done to secure their balance sheets and liquidity. To assist this process, Basel III was implemented, requiring banks to retrench lending in order to focus on building their reserves to comply with new capital adequacy requirements. A reduction in available credit provided an opportunity for credit funds and alternative lenders to enter the market, offering a range of different funding solutions, and thus providing variety and flexibility to borrowers.

Banks

With borrowing costs low, high street banks are well positioned to provide cheap, secured finance solutions to businesses. These facilities are good for stable businesses that do not require significant leverage and that can demonstrate consistent, predictable cash flows. Bank debt is usually tightly controlled by way of covenants, usually requiring some degree of amortisation, coupled with cash payments of interest. These are therefore not always ideal for businesses going through significant change, be it fast growth, expansion, M&A activity and/or turnaround.

Debt funds and alternative lenders

Where businesses are seeking more bespoke funding, such as M&A or growth finance or where cash conversion in the near term is more problematic, debt funds and alternative lenders may be well placed to step in and provide innovative funding solutions. These are typically more expensive than conventional bank finance, however they provide greater flexibility, allowing borrowers to defer initial capital repayments in order to free up cash in the near term.

Debt funds are also well placed to provide subordinated tranches of debt, such as mezzanine or preferred equity.  It is not uncommon for funds to provide finance across the capital structure, such as unitranche facilities, which cover senior and subordinated tranches in one solution. Debt funds can generally accommodate larger amounts than what may be offered by an individual bank, thus providing additional and greater flexibility.

Asset backed lenders

The changes in the economic environment have also created opportunities for asset backed lenders (ABL). ABL encompasses invoice discounting, stock finance, trade credit and plant & machinery finance.  Widely seen in the past as a ‘lender of last resort’ and well used in restructuring scenarios, improvements to technology and the lending platforms these funders employ have now made it a credible source of finance for businesses. Due to the security provided, lenders typically have a lower cost of borrowing and are typically able to pass this on in the form of cheaper finance solutions.

Bonds and private placement

Where a business has a proven track record it may seek finance with reduced covenant controls. Bonds are traded debt instruments that allow the investor in the bond to trade their holding at any point, whilst private placements are sold to a select group of sophisticated investors. These typically provide the borrower with flexible end of term, all-bullet structures.  However this flexibility comes at a price in terms of the rate of interest charged and the up front arrangement fee.  Generally, the longer the debt’s duration, the higher the interest rate charged, as this is the way that investors price in the added uncertainty.

How to decide what funding option is right for your business

When deciding which lender, or funding solution, to pursue, it is well worth considering the following key points and getting expert advice early in the process to assist you in your deliberations.

  • Are your current lenders people that you can work with?
  • Do they understand your business and/or provide experience that adds value?
  • Do they have experience in your market and understand its dynamics?
  • Are they fully aware of the issues that you are going to face as your business grows?
  • Will they provide the flexibility and support that you need to keep growing?
  • Are they going to be willing to provide enough headroom to support future growth?
  • Are they factoring in appropriate provision for capex and working capital requirements?

Contact us

If you would like to discuss how we can support you on a business acquisition, then get in touch to arrange a free no-obligation initial meeting with our multi award-winning team. For further information please call 01908 662255 or e-mail: laurence.whitehead@mhllp.co.uk

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